European politics

Europe's debt crisis

At bursting point?

THIS grotesque map of the world, depicting Europe as a bloated balloon, caught my eye this week, and powerfully illustrates one of the factors in Europe's debt crisis. It depicts the countries of the world sized according to the amount of government spending*.that they spend on social protection, from pensions to health, education and unemployment benefits.

In the words of the World Bank, which published it in a report issued this week ("Golden Growth: Restoring the lustre of the European Economic model", here), Europe is the world's “lifestyle superpower”. As opposed to America, which spends almost as much as the rest of the world put together on defence, Europe spends more than the rest of the globe combined on social policies.

In many ways this is an admirable aspect of Europe's economic model, which combines high living standards with high standards of social welfare. The trouble is, such spending is helping to bankrupt governments—not least because those very same caring policies ensure that Europeans live longer, requiring more expenditure on health care and the payment of pensions for more years.

Anybody who wants to understand the strengths and weaknesses of European economies in this time of crisis would do well to read the report (the overview is here).

First the strengths. Europe, say the authors, invented a unique “convergence machine” by admitting successive waves of poorer countries and quickly raising their standards of living. Convergence has been accelerated by the free flow of trade and capital within the European Union. As the report puts it:

Between 1950 and 1973, Western European incomes converged quickly towards those in the United States. Then, until the early 1990s, the incomes of more than 100 million people in the poorer southern periphery—Greece, southern Italy, Portugal, and Spain—grew closer to those in advanced Europe. With the first association agreements with Hungary and Poland in 1994, another 100 million people in Central and Eastern Europe were absorbed into the European Union, and their incomes increased quickly. Another 100 million in the candidate countries in Southeastern Europe are already benefiting from the same aspirations and similar institutions that have helped almost half a billion people achieve the highest standards of living on the planet. If European integration continues, the 75 million people in the eastern partnership will profit in ways that are similar in scope and speed.

Yet this convergence machine is spluttering, and deep reforms are needed. Much effort has been expended on explaining the nature of the financial crisis of the past two years. The sharpest and most concise analysis I know of is a recent policy brief by Jean Pisani-Ferry, director of the Bruegel think-tank in Brussels ("The euro crisis and the new impossible trinity", here). This argues that the problems are deeper than a lack of fiscal discipline: there is a flaw in the way the euro zone was designed, without a lender of last resort, without joint bonds and with a vicious feedback loop that weakens both sovereigns and their banks. There is a tendency in Brussels to think that, if only the euro zone were to make the leap to federalism, all would be solved. Far from it.

The World Bank report shows that Europe has deep structural flaws to contend with. Perhaps most worrying is the slowdown in labour productivity, the underlying driver of economic growth over the long term. This chart (right) shows how Western Europe had almost closed the productivity gap with America by 1995. But thereafter it started to lag ever farther behind the United States (and kept losing its lead over Japan).

The effect is most alarming on the Mediterranean rim. These next two charts show that, as expected, in 2002 northern Europe was more productive than southern Europe, which in turn led the new member states of eastern Europe. But between 2002 and 2008 something strange happened. The convergence machine went into reverse for southern Europe. While the easterners were roaring ahead to catch up with the northerners, prroductivity in Mediterranean countries actually fell.

Part of the reason is contained in this chart (right). It shows how foreign direct investment was abruptly redirected from southern countries to the new member states in the east. Mediterranean members faced a triple challenge: they were hit hard by globalisation and the loss of low-tech industries such as textiles; they faced competition from cheaper labour in ex-communist members; and the adoption of the euro made it harder for them to adjust through devaluation. Yet Club Med has only itself to blame.

A premature adoption of the euro by southern economies is sometimes blamed for this reversal of fortune. Others say that letting the formerly communist countries into the European Union so soon did not give the south enough time to become competitive. But perhaps the most likely explanation is that of all the economies in Europe, the entrepreneurial structures of Greece, Italy, Portugal, and Spain were least suited for the wider European economy. For one thing, a sizable part of net output in southern economies is generated in small firms—almost a third of it in tiny enterprises (with fewer than 10 workers). This is not an entrepreneurial profile suited for a big market. Unsurprisingly, with the expansion of the single market in the 2000s, foreign capital from the richer economies of Continental Europe quickly changed direction, going east instead of south as it had done in the 1990s.

Did the south need more time to adjust, or did it squander opportunities? The latter seems more plausible. Ireland has shown that EU institutions and resources can be translated quickly into competitiveness. The Baltic economies are now doing the same. The chief culprits for the south's poor performance were high taxes and too many regulations, often poorly administered. While these mattered less when its eastern neighbors were communist and China and India suffered the least business-friendly systems in the world, they are now crippling southern enterprise.

All is not lost. Northern European states, especially Nordic countries, show it is possible to innovate, raise productivity and maintain generous social welfare at the same time. This is the World Bank's explanation for their success:

What has the north done to encourage enterprise and innovation? Much of its success has come from creating a good climate for doing business. All the northern economies are in the top 15 countries of 183 in the World Bank's Doing Business rankings; at 14th, Sweden is the lowest ranked among them. They have given their enterprises considerable economic freedom. Their governments are doing a lot more. They have speeded up innovation by downloading the “killer applications” that have made the United States the global leader in technology: better incentives for enterprise-sponsored research and development (R&D), public funding mechanisms and intellectual property regimes to foster profitable relations betweenuniversities and firms, and a steady supply of workers with tertiary education. Tellingly, Europe's innovation leaders perform especially well in areas where Europe as a whole lags the United States the most. These features make them global leaders; combining them with generous government spending on R&D and public education systems makes their innovation systems distinctively European.

Even so, there are reasons to worry, even in northern Europe. For instance:

What has been more perplexing is Europe's generally poor performance in the most technology-intensive sectors—the Internet, biotechnology, computer software, health care equipment, and semiconductors. Put another way, the United States, the Republic of Korea, and Taiwan, China, have been doing well in sectors that are huge now but barely existed in 1975. Europe has been doing better in the more established sectors, especially industrial machinery, electrical equipment, telecommunications, aerospace, automobiles, and personal goods. The United States has young firms like Amazon, Amgen, Apple, Google, Intel, and Microsoft; Europe has Airbus, Mercedes, Nokia, and Volkswagen.

The productivity gap is especially important in Europe, given that Europeans tend to work less than Americans, while spending more on social protection.

The hallmark of the European economic model is perhaps the balance between work and life. With prosperity, Americans buy more goods and services, Europeans more leisure. In the 1950s, Western Europeans worked the equivalent of almost a month more than Americans. By the 1970s, they worked about the same amount. Today, Americans work a month a year more than Dutch, French, Germans, and Swedes, and work notably longer than the less well-off Greeks, Hungarians, Poles, and Spaniards..

And on top of fewer working hours in the day, and taking longer holidays, Europeans have tended to retire earlier—even as they lived longer. By 2007, the French could expect to draw pensions for 15 years longer than they did in 1965. On current trends for immigration and participation in the workforce, says the World Bank, the 45 European countries in its study will lose 50m workers over the next 50 years. Which brings us to that spending bulge.

Europe's states are not big spenders on either health or education. The variation among countries stems from a difference in spending on pensions and social assistance. Europe's countries also differ how they tax these benefits; Northern European countries tax the social security benefits of people with high incomes more than others in Europe. After taxes are considered, the southern periphery is the biggest social spender in Western Europe. But the reason why Europe spends more than its peer on public pensions is the same in the north, center and south. This is not because Europe has the oldest population (Japan's is much older) nor because of higher pension benefits (annual subsidies per pensioner are about the same in Greece as in Japan). It spends more because of easier and earlier eligibility for pensions.

So the outlook is gloomy. Even with greater productivity, even if governments can reduce unemployment and bring more women into the workforce, Europeans will have to stay in work for many more years. Even so, the workforce will decrease. So Europeans will have to rethink migration policies too.

* A correction to my post last night: the World Bank's map is sized according to all government spending, not just spending on social policies. The World Bank tells me the map would be even more distorted were it to focus only on public spending on health, education and welfare benefits.

Also the second chart doesn't tell us if the 'growth' is measured in USD, EUR or in -perhaps- devalued domestic currencies, as this was the case with the U.K. after 2008 when the GBP slumped approx 30 percent against the Euro.

Have the grace to admit when you mispoke – it's no big deal. But don't tell me I "misread" what you said when it's plain out there for everybody to see what you wrote. I consider that intellectually dishonest and an insult.

Speaking of insults: when a comment starts by smearing me like this:

"You've had these sort of conflicts with other posters who seem all to share the same opinion about you."

... I do not bother enough to read any further. You will understand that I stopped right there.

I will say that much:

Primo - I'm virtually immune to bullying, and am also not looking for friends, so I'm unimpressed.

Secundo - Given the fact that the smallest common denominator of what you describe as "everybody" and I will call "team Sanmartinian" for the purpose of this reply is a shared conspiracy theory, I actually make a point of being my own man. I prefer to use my brain to switching it off when doubts arise.

Tertio - If you want me to share some of the observations I have made with regard to your interaction on this board, let me know. I'll be happy to comply. I will tell you that much: The two of the regulars here who refuse to be "enlisted" in either team A or team B are quite happy with it. I let you guess who that other person is.

I'll leave it at that. When you feel fit to argue your case without insulting me, you are welcome to do so. If not, "don't bother to reply", as you have the habit of telling others.

With no reference to GDP and types of services provided by the state, the comparison looks shallow. If social costs and government revenue spending been the only deciding factors, then Scandinavia would have been buried deep in permafrost. For sure, productivity matters a lot. For explaining that, one has to look at, apart from just the budget and debt angles, also the relative standing in terms of technology, cost, culture of innovation and open-ness and linkages in big and emerging sectors, and relevance in world economy.
The last 2 decades have also seen a huge leap in commodity and energy prices that has had devastating impact on relative economic strength. USA barely escaped. Not least because the world can't do without its currency; USA kept importing (incl outsourcing from Asia) low-cost labour and has space to offer to immigrants; and US dependency on imported energy came down. Most of the winners from the oil-deficit zones had something special to offer. Special and big.
Another of Europe's main failings internationally has been its inability to extract price for its products, systems and cultural values from the surplus-producing and big saver countries. US uses a version of English for its dealings; Russia, Russian; China, Mandarin. Even the current gap is being seen more as a split between the Nordic-Germanic part and the Club Med Latin part, with France sticking to the perceived winner. Cutting down social spending won't save the troubled members of the EU.

Interesting article. But, I think the World Bank's sceptical conclusions about fiscal consolidation are wrong.

We have a tendency in Italy - separated from the rest of Europe by the Alps - to consider our own mess a purely localised problem. Both the inhabitants of the peninsula and the rest of Europe tend to buy into Vatican-sponsored propaganda that would depict Italy as a small country. We are not, and our tendency to influence (usually negatively) on European events is routinely underestimated.
(Please pardon this premise...)

Yes, there is clear evidence Italian productivity has declined (marginally) and it is easy to see the connection between rapidly shifting FDI toward Central Europe and away from southern Europe over the last decade (not to mention the fact that it is hard to see ANY FDI in Itally over the last decade - for example, we are the only G7 country not to have a foreign auto factory).

What the article does not explain (not in the report?) is that much of the FDI going into Central Europe came from Italy itself. Our country is one of the world's largest sources of FDI - and largely going toward Central Europe over the last decade.

Why? Two reasons, in my experience:

1) To avoid excessive taxation in Italy - and labour market rigidities and higher wages (this differential is disappearing however); there has also been a fall-off in the vocational training programmes of the past, i.e. we are starting to lack qualified technicians among the younger generation.
These factors have led to an end of investment for the future by our own resources - and it is directly related to the excessive debt burden we have been servicing for over two decades.
This is the fault of our ex-Christian Democrats who have supported Berlusconi all these years, in the hope of preserving their excessive pension benefits and undeserved board memberships of the State "underbrush" (sottobosco) as we call it here. It is not uncommon for "retired" politicians to sit on 3 or 4 boards of various local social, financial, cultural or industrial consortia.

The excessive debt burden has a doubly mortifying effect since anywhere from 54% to 80% has been in domestic hands over the last 2 decades: hence, many wealthy individuals and institutions have lived a rentier economy - and not invested in job-producing activities.
As a side note, I would remark that our country's citizens have spent massive amounts of money in the last two decades to renovate our housing/real estate assets. This was needed, but the investments in brick and mortar (and not machinery and companies) also did not produce jobs.

2) GreatMongo has a point about low birth rates caused by lousy child care benefits. I should explain that the Catholic Church has always blocked the establishment of structures outside the family here. MOTHERS and GRANDMOTHERS should be responsible for day care, in their view, and the state should not be creating parallel structures. Result: Mothers/Grandmothers in 2012 always tell their married daughters, "Whatever you do, do not have more children - I am sick and tired of raising kids." (At age 60, an entirely understandable position).
Plus, it still requires a minimum of 3 years to obtain an uncontested divorce with no children. God forbid there are children involved - divorces can easily take upwards of 4-6 years through bureaucratic delays, etc. Once again, the Church imposes its will on Italians.
Result: Italian women do not want to marry (either in church or in the town hall) and they DEFINITELY do not want children.

Let us not underestimate this dynamic - wholly ignored in the report. Every Italian entrepreneur in the world is also looking to marry a non-Italian woman - it's part of building a company, and building a family. It can hardly be done in Italy, unless the family are already millionaires.

So, hundreds of thousands of Italians have brought their capital with them to Central Europe: let's start a family and open a business.
If I had more capital available at the moment, I would be doing the same - and all my friends here around Trieste discuss the same possibility.

In the era of a multi-religious, global economy, the Vatican is once again responsible for the economic, social and even biological oppression of the Italian people.

"The United States has young firms like Amazon, Amgen, Apple, Google, Intel, and Microsoft; Europe has Airbus, Mercedes, Nokia, and Volkswagen."
In other words, the EU is still creating wealth and employing folks who know how to use their hands, whereas the US is trading chits in retail encounters that merely absorb wealth instead of creating it. In the few real jobs that remain, the US is employing a tiny slice of highly and narrowly trained technical specialists. Lucky US. Airbus and poor old dying Boeing generate more real disposable income for more people in six months than Google has in ten years, or will in the next twenty.
Oh, and woe betide the EU for trying to keep people healthy and happy; there's a policy fail for certain, eh? Care to look at per capita healthcare expenditures? Thanks for yet another boring operatic solo to the effect that the European middle class is too large, too rich, and too healthy. Sounds awful. F*ck you very much.

All European banks could lend to any European government holding zero or 1.6 percent in capital, according to the quite recent credit ratings of the sovereign, but, have to hold 8 percent when lending to a small business or entrepreneur. That has introduced a huge bias in favor of channeling the savings to the public sector, and the figures here are just a reflection of said reality.

It is not the government spending on social welfare, health, education, and other necessities that has created a problem for Europe. It is the "RECKLESS" government spending that has created a problem. Reckless government spending occurs in all countries more or less, it is just that countries like Australia have the mining boom to rely on.
To question government spending on the necessities, while other governments spending on bailing out greedy corporate bankers does not reflect a perfect picture on the situation. Not to mention the hardcore contradictions in the socialist, and capitalist ideologies.
Let's not forget that it is the EU Model, where some countries spend, others earn, that has created this uneven equilibrium that is threatening to destroy the union, and in effect the rest of the world.

If the writer or anybody that writes about let s say Italy truly knew Italy it would soon realize that all the theoretical talk is , well , just a hot balloon good for an article on the economist , good for neoconservatives or neoliberlas campaigns but not much more. Let' look at reality in Italy: a lot of tax evasion, a lot of black economy and a lot means a LOT. Ever gone to a doctor in Italy? You will be submerged with prescriptions that are of dubious value dubious need but certainly cheap. Ever worked in Italy? A piece of mail in Italy takes weeks to go from Milan to Palermo. These FACTS have nothing to do with theory of gvnmt spending but ALL TO DO with professionalism honesty corruption nepotism . When will economists stop thinking they know by looking at numbers and walk the streets of Reggio Calabria ?

From a silly layman to two intelligent but presumably also laymen on comparative efficiencies.

DEA (Data Envelopment Analysis), is a mathematical tool first put forward by Charnes, Cooper and Rhodes in 1978. It can be used to measure the relative efficiency of units.

Relative efficiencies are measured in physical units such as number of transactions done by a bank employee, number of shoes made by a machine, passenger miles flown by airlines, gold medals won at Olympic Games and so on.

Overall measurement units, such as money, are stark verboten. Money has also the even greater disadvantage that it varies in value in time, place and market.

That's why models put forward mostly by the Groningen University and much loved by "econometrists" cannot be used to compare productivity ( a form of efficiency).

DEA looks at units (called DMU Decision Making Unit) and read their outputs produced by inputs.

Weights are then given to them to compare their real contribution.

The beauty of DEA is that these weights are not chosen by the analyst (that would make them subjective) but by the process itself.

The system calculates benchmark DMU against which the others are measured.

The whole thing is translated into what old mathematicians would have called a boundary but is now called frontier giving the whole thing a taste of cowboys and red indians.

The frontier is a broken line separating efficient DMU from non efficient ones. Further complicated techniques like smoothing the frontier to avoid mathematically inconvenient sharp points or negative efficiencies are used, but that would take us too far.

To copy and paste (I didn't ask for permission; I believe it would be granted) from J E Beasley, the author of OR notes: DEA has been used in banks, police stations, hospitals, tax offices, prisons, defence bases (army, navy, air force), schools and university departments.

I can add it has been used in sports rankings such as Olympic Games.

One day it'll be used to measure productivity without the silly results obtained by some economists.

1) No, I don't mind if others "point to my weaknesses". I'm even still talking to you although you do nothing else of late (and haven't even reciprocated yet, although you are asking for it).

2) Funny that you keep accusing me of wanting "to appear to be right to the very end", while you've been trying to convince me for three days now that I misread and you didn't misspeak when you said enlargment happened too early. I repeat: A simple clarification would have done it, I didn't put you in a box labelled "anti-Eastern European" then and I don't do it now. Rephrase it, for God's sake, and that's it.

3) As for me being confrontational in a debate – I confess. Déformation professionelle... . But I hardly ever hold a grudge. Life is too short for resentment.

I suggest we both elevate the conversation above the pettiness of the lasty 24 hrs and move on.

On that note.

*I'm protesting against this new design which has made posting and finding posts so tedious.

Why must the parties of the left, and the unions in particular, be so fundamentally predisposed to supporting huge deficits? This is almost universally the case, affecting the UK, continental Europe and the US. The principle job of the left is to support progressive taxation and widen access to high status jobs. What political handbook espouses this addiction to burdening the state and future generations with massive debts to support profligate welfare policies?

Time and again this economic illiteracy is presented by dishonest left wing representatives who will not admit the true cost of their agenda to a fickle electorate. Francoise Hollande's electoral platform seems to be the latest manifestation of this insanity. For this reason the proposals for balanced budget amendments should be welcomed. This will collectively force the left to present their agenda honestly and rigorously.

and I am beginning to sound incredibly silly (yes you can make the joke ... beginning? I won't mind :-)) because I've reposted excerpts this poem non-end .
Thanks to evolution, humans are driven by catchwords, buzzwords, and things that don't make them have to think much.
It's a question of survival. If you were being attacked by a lion, would you start calculating the time it'd take you to climb atop the nearest tree so that the lion wouldn't catch you, or would you just climb it? Duuh?
This has advantages and disavdantages.
One of the worst disadvantages is that this leads to some kind of 'herdlike' behaviour, whereby we're all driven to think the same, behave the same, and act the same, and unfortunately say the same, at one given point in time.
Today's buzzwords are : bubbles, burst bubbles, government debt, deficit, defaults.
I am pretty certain these 4 or 5 words appear on at least in between 50- 75% of all the articles that are published in the economist, or others.
I think we should worry about these things, but I never liked to be 'herded'. Thinking outside the box is my attempred mot-de-vie, or at least I try it to be so.
In a few years time, we'll be debating completely different things. I personally have no doubts about it.
What is so worrying about this current frame of thought, if I may be allowed to express myself so, is that it's very limited. It puts deficits/debt/etc. above human dignity . It's somewhat perverse.
It's all the banks fault and deep down we all know this. Yet it's the average Joe, especially the poor, dirty, ugly, and stinky southerner that is being forced to pay. I know it's not as simple as that. But in many ways it IS like that.
What's the point of living in a society that hoovers your pockets dry, so it can support a zombie financial system which lives off bouts of 'liquidity injections' from its respective central bank, and then taxes the average citizen more and more and more and more to pay for all that?
This is the reason I find the most recent Charlemagne article slightly perverse. It's not about bubble-bursting. It's about politics, and about us. It's the people, stupid?.
Sometimes some poeple like him admit to this, some times they don't.
Bu tthey are perfectly aware than in 10 years time things will be very different. Hopefully for the better.
And the euro has nothing to do with it. It was simply ill designed. And is being mended. In a far greater speed than some would have thought it would